The cost of education is rapidly increasing. With student loan debt now being the second highest consumer debt category, trailing mortgage debt, the stakes of college planning are high and there is not much room for error. Here are some common mistakes that parents make when planning for their children’s college education.
There is no shortage of expenses for families with young children these days. As families expand, additional expenses, such as childcare, begin to put pressure on the family budget. When you factor in the added responsibilities of retirement and healthcare, it is very easy for college savings to get lost in the shuffle. When parents are starting out, college seems so far away that often people procrastinate on taking action until it is too late. Compounding growth is a powerful force, but it needs time to build momentum.
Not Taking Advantage of 529 Plans
When it comes to places to save money for college, it is hard to beat the 529. Over 30 states including the District of Columbia offer a state tax deduction if you contribute to the state plan and are a resident of that state. New Jersey does not offer this benefit, but the 529 plan is still worth using even without the state deduction. The investments within the account grow tax-free and the distributions are tax-free if spent on qualified higher education expenses. If a nonqualified distribution is taken, then ordinary income tax on the gains plus a 10% penalty would apply.
If a child decides not to attend college, the account beneficiary can be transferred to another family member, including a parent. Also, you can take a distribution that will be exempt from penalty for the amount of a received scholarship, although the gains will still be taxable as ordinary income. Something else to consider is that even if the tuition is fully covered by scholarship, there are plenty of other expenses, like lodging or books, which may not be included in the scholarship that would be covered by the 529 plan as a qualified distribution.
Not Filling Out the FAFSA Form
The Free Application for Federal Student Aid form (FAFSA) is the application that determines the federal financial aid a student is eligible to receive by calculating their expected family contribution (EFC). The EFC is based on a formula that mainly factors the income and savings of the student and their parents with a few additional variables.
However, sometimes parents believe they make too much money to qualify for aid at all, so they do not fill out the form. This could be an expensive mistake. Even if a student does not qualify for need-based aid, often universities will give out merit aid based on the achievements of the student, like good grades, which does not factor in financial need. In order to be eligible for this type of award, the student will still need to have filed the FAFSA, and they could be leaving money on the table if they do not.
Knowing What Assets are Counted and Their Impact on the FAFSA Formula
A large point of confusion is figuring out what assets are included and excluded on the form and how they are weighted. For example, from a FAFSA calculation standpoint, money held in the student’s name is weighted more heavily–at 20%–than money in the parent’s name, weighted at 5.64%. So, if the student had $10,000 in a mutual fund, the FAFSA would calculate that the student needs to apply $2,000 of that money towards their EFC. Likewise, if that money was in a 529 plan owned by a parent with the student as a beneficiary, not only would the student get the tax benefits of the 529 plan, but the asset would be considered under the parents and weighted much lower at a $564 EFC.
Not Understanding the Ramifications of Student Debt
There are so many different types of student loans and student loan provisions that the topic could warrant a book on the subject. However, there are some general guidelines to consider if a student is contemplating taking out debt to finance their education. Generally, federal loans have lower interest rates and have more favorable repayment terms than private loans, so that is a great place to start looking. However, students with excellent credit may be able to find a better deal in the private market. Student loans are also notoriously difficult to have erased in bankruptcy. Student loans can be erased under certain hardship circumstances, but it is very rare.
College planning is challenging. Every family’s situation is different, and the best strategy for one family might not be the best for another. The links below contain additional online resources with more information on the FAFSA and college planning: